December 8, 2023

Fitch Ratings, a prominent credit rating agency, recently downgraded the United States’ sovereign credit grade from AAA to AA+ on account of mounting fiscal deficits and perceived governance erosion, leading to recurrent debt limit clashes over the past two decades. This decision echoes a similar move made by S&P Global Ratings over ten years ago. Fitch expressed concerns about budget deficits resulting from tax cuts and new spending initiatives, and the unaddressed challenges related to rising entitlement costs. The downgrade prompted reactions from US Treasury Secretary Janet Yellen, who called it “arbitrary” and “outdated,” while some economic commentators expressed surprise and questioned the timing of the announcement.

Rationale Behind Fitch’s Decision: Fitch’s statement highlighted the expected fiscal deterioration over the next three years, as well as the increasing general government debt burden, relative to ‘AA’ and ‘AAA’ rated peers. The agency emphasized that repeated debt-limit clashes and eleventh-hour resolutions have undermined confidence in the country’s fiscal management. Fitch projected the US’s debt burden to reach 118% of the Gross Domestic Product (GDP) by 2025, significantly higher than the ‘AAA’ median of 39.3%, and warned of further increases in the longer term, making the nation more susceptible to future economic shocks.

Mixed Reactions: While the Treasury yields edged higher after the announcement, some experts were puzzled by Fitch’s decision, including the timing of the downgrade. Former Treasury Secretary Larry Summers and Allianz SE’s Chief Economic Adviser Mohamed El-Erian expressed their surprise on social media. The move could pose challenges for funds or index trackers mandated to hold AAA-rated assets, as the US now holds two AA+ ratings. Moody’s Investors Service still maintains its Aaa rating for the US sovereign, the highest grade.

Impact on US Politics: Following the downgrade, Democrats in Congress blamed Republicans for creating a “manufactured default crisis” and causing the second credit rating downgrade. On the other hand, the House GOP campaign spokesman attributed the downgrade to “Bidenomics.”

Market Response: Yields on two-year Treasuries fell after the downgrade, indicating increased demand for safe-haven assets. However, the market’s reaction remains finely balanced, with potential implications for US Treasuries and the dollar, depending on investor sentiment and risk-off moves.

Fitch Ratings’ downgrade of the US sovereign credit rating reflects mounting fiscal deficits and concerns about governance practices. While US officials have criticized the decision, it highlights the need for addressing long-term fiscal challenges and restoring confidence in fiscal management. As market reactions unfold, investors and policymakers will closely monitor the potential implications for US borrowing costs, market dynamics, and economic stability.

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